Solutions_wk10 - Solutions Tutorial Week 10 Chapter 17 11....

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Solutions Tutorial Week 10 Chapter 17 11. We begin with r E and the capital asset pricing model: r E = r f + E (r m r f ) = 0.10 + 1.5 (0.18 0.10) = 0.22 = 22.0% Similarly for debt: r D = r f + D (r m r f ) 0.12 = 0.10 + D (0.18 0.10) D = 0.25 Also, we know that: 17.0% 0.17 0.22) (0.5 0.12) (0.5 E D A r E D E r E D D r = = + = + + + = To solve for A , use the following: 0.875 1.5) (0.5 0.25) (0.5 E D E E D D E D A = + = + + + = 12. We know from Proposition I that the value of the firm will not change. Also, because the expected operating income is unaffected by changes in leverage, the firms overall cost of capital will not change. In other words, r A remains equal to 17% and A remains equal to 0.875. However, risk and, hence, the expected return for equity and for debt, will change. We know that r D is 11%, so that, for debt: r D = r f + D (r m r f ) 0.11 = 0.10 + D (0.18 0.10) D = 0.125= 0....
View Full Document

This note was uploaded on 05/12/2010 for the course COMMERCE finc at University of Sydney.

Page1 / 5

Solutions_wk10 - Solutions Tutorial Week 10 Chapter 17 11....

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online